Business Overdrafts

What is a Business Overdraft?

A business overdraft it is a line of credit attached to a business account which allows you to continue to access money even after your account balance drops below zero, similar to a personal overdraft.

A business overdraft can be useful for settling invoices, covering overdue invoices, and paying for unexpected expenses such as unexpected bills or covering supply chain issues.

Read on to learn about business overdrafts and what you need to know to decide whether an overdraft is suitable for you.

How does a business overdraft work?

Your bank will usually set an amount you can still access if your balance goes below zero. The limit can vary widely and depends on several factors, like your business turnover and credit history.

If your business grows and your cash flow increases, the bank may increase your overdraft limit, but only if they believe that the business can pay back the additional funds borrowed.

Alternatively, a bank may offer you a 'secured' overdraft which means that you will need to provide a business asset, such as commercial property, as collateral to offset the bank's risk.

If you have a secured overdraft and you cannot pay it off within a certain time period, the bank has the legal right to sell your asset to recoup the outstanding balance.

How do I get a business overdraft?

Setting up a business overdraft usually can be arranged by visiting your bank’s branch, speaking to the bank over the phone, or applying online via the bank's website. Typically, you will need to have an existing current account to be eligible for a business overdraft.

To qualify for a business overdraft, you must be trading as a sole trader, partnership or limited company, and you will also need to meet your bank’s eligibility criteria. This process involves assessing your:

• Business history
• Financial history
• Personal credit history
• Business credit history

You will also be asked how you will use and repay the overdraft. The larger the overdraft, the more details you will be asked for when applying. In addition to this, you will also need all your business details including your Company's Registration Number and all the personal details of all the partners and directors of the business.

There are two types of overdraft requests: arranged and unarranged. With an arranged overdraft you have an agreement in place before you start using your credit. An unarranged overdraft is when your balance goes into the negative without contacting your bank. This usually results in higher interest rates than compared to a pre-arranged, formal overdraft.

Be aware you will have to pay interest on the amount of credit borrowed from the bank. An overdraft will only charge you interest on the amount of credit you have overdrawn. This could be a fixed rate of daily interest or increase as you borrow more.

What are the advantages of a business overdraft?

• High rate of approval - there usually aren’t any issues with arranging a business overdraft.
• Quick to arrange - it is a very straightforward process, like we said above, and is usually just a matter of talking with your bank.
• Short-term cash flow - business overdrafts are very helpful to seasonal businesses to cover short-term cash flow shortages.
• Pay off the debt when your cash flow allows it - usually, you can repay the money you’ve overdrawn whenever you have the fund to do so, although it is important to bear in mind that banks sometimes demand repayments at a particular time.
• Interest is only on the money taken out - you will only be charged interest on the overdraft funds you withdraw.

You can also always opt-out of the business overdraft facility if you find that you simply don’t need it anymore and there is no fee on paying back the overdraft if you are capable of doing so sooner than expected.

What are the disadvantages of a business overdraft?

• Product fees - if you are late with a repayment that your bank has requested or you miss a payment altogether, you may be charged a fee that can affect your credit report.
• High-interest rates - generally interest rates are higher for business overdrafts than for a business loan or other forms of borrowing.
• Repayable on demand - this is where you are required to repay the overdraft in full on request, although this isn't common practice.

Some things to consider before applying

Overdrafts are only a short-term solution, as interest rates are high and can change at any given time. They can also vary between banks.

Secondly, as well as interest charges, you may also be charged for:

• Application fee - most banks do not charge this, so if your bank does, you may be able to save money with another provider.
• Accounting-keeping fee - this is an ongoing fee charged by your bank for managing the overdraft.
• Arrangement fee - this is for setting up the overdraft.
• Renewal fee - this is oftentimes an annual fee when you come to renew this facility.
• Change fee - this for when you change (usually increasing) your business overdraft limit.
• Unarranged overdraft fee - this is a fee for when you go over the limit of your existing overdraft. This can be a pretty sizeable fee.

If your business has been not been approved for a business overdraft from your current banking provider, the Bank Referral Scheme means your bank has an obligation to provide you with alternative options if you are not eligible for their product.

Bottom line

Every business is different so applying for a business overdraft is not the only option for securing extra funds.

There are other sources of funding available for businesses and we would encourage you to consider all your options carefully before deciding which product is right for you.